Sept 9 (The following statement was released by the rating agency)
Fitch Ratings has assigned Continental AG and Continental Rubber of America, Corp's (CRoA) notes Long-term senior unsecured ratings of 'BBB'. This rating is in line with Continental AG's Issuer Default Rating of 'BBB'. Continental AG issued a seven-year EUR750m eurobond with a 3.125% coupon on 9 September 2013, a five-year EUR750m eurobond with a 3% coupon on 16 July 2013 and CRoA issued a seven-year USD950m note with a 4.5% coupon on 24 September 2012.
KEY RATING DRIVERS
The upgrade of Continental AG on 15 July 2013 reflected Fitch's assessment of the parent-subsidiary linkage between the Schaeffler Group and Continental AG. Fitch now deems the linkage weak enough to rate Continental on a standalone basis. The linkage has been weakened by Schaeffler reducing its stake to 49.9%, Continental extending its bank debt agreement with tight ring-fencing of cash flows to 2018 and Continental's independent dividend distribution policy. A strengthening of the linkage is considered unlikely and would be treated as event risk.
Strong Business Profile
Continental's ratings reflect its large manufacturing operations, global footprint, top ranking positions in the markets in which it operates, solid end-market diversification with about 30% of sales in the less volatile replacements business and strong R&D capability.
The company's financial profile is strong and relatively resilient against the cyclicality and volatility experienced in the automotive supply industry. Fitch expects EBITDAR margins of 15% for 2013 and beyond. Profitability is also supported by Continental's tyre business which accounted for 40.5% of 2012 sales and resulted in an EBITDAR margin of about 19%.
Strong Free Cash Flow
The Stable Outlook reflects Fitch's expectations that Continental's solid underlying funds from operations (FFO) margin will remain at approximately 10% in the next couple of years. This would be sufficient to cover the high 6% capex to revenue outlays and the company's conservative dividend policy. Fitch expects the free cash flow (FCF) margin to remain in the range of 2.5%-3.5% in 2013 and beyond.
The Stable Outlook is further supported by Fitch's expectations that Continental's FFO adjusted leverage will decrease to well under 2.0x during 2014 from 2.3x at end-2012 and from a peak of over 6.0x at end-2007.
Fitch estimates that cash and undrawn committed credit facilities amounted to around EUR4.2bn at end-June 2013. Fitch expects FCF of at least EUR1bn in 2014 and beyond. Given its liquidity generating ability, Continental opted for early redemption since July 2013 of three bonds amounting to EUR2.375bn and issued two bonds amounting to EUR1.5bn.
Raw Materials Exposure
Raw materials (RM) constitute a major part of Continental's cost structure and the historical high volatility of their prices has been a significant driver of the group's profitability. Continental does not actively hedge against the risk by using derivative instruments but intends to compensate for or pass on its increased costs to customers. A portion of this cost is typically hedged and covered by RM clauses, but these clauses and hedges only protect for a limited period of time. Continental currently benefits from significantly reduced RM prices and continuing demand especially in the replacement tyre business driving the high profitability performance.
Strong FCF Margins
Positive rating action may occur if, on a sustained basis, EBITDAR margins increase to above 15%, FCF margins improve to 3.0% and FFO adjusted leverage falls well below 1.5x. Fitch believes that given the independent dividend policy and some discretionary capex outlays currently, Continental has sufficient headroom to achieve these guidelines within two years.
An increase in FFO adjusted leverage to above 2.0x or FCF margins falling to or below 1% to 2% may result in a negative rating action.
Any change in Schaeffler's influence on Continental resulting in a weakening of Continental's credit profile could lead to a reassessment of Fitch's standalone approach to Continental's rating. This may also occur in case of a merger of Continental AG with Schaeffler Group, if this combination led to a deterioration of the consolidated financial profile.